from Follow the Money

Gone Fishing

July 30, 2018

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I am planning to take the next few weeks off—no blogging. That at least is the plan, barring a major financial surprise.

It thus seems a natural time to look back at the topics I have covered in the first seven months of the year.

More on:

International Economic Policy

Trade

Capital Flows

And maybe this back catalogue can serve as at least a partial substitute for new content?

The bulk of my recent output has focused on China. The coming trade war and all.

I put a lot of work into the links in my post on the back story to the trade war. There is also a lot of material on bond market dynamics buried inside my post on China’s options for responding asymmetrically to an escalation in the scale of Trump’s tariffs. The argument that China has more to gain from letting the yuan depreciate than by selling off its Treasury portfolio has held up well so far.

Another focus has been the technical details of China’s currency management, and shifts in the pattern of capital inflows to and from China. I think it is significant that financial flows into China were fairly balanced heading into the trade war—with China able to add to its reserves at the margin even while funding Belt and Road related outflows. That though may change in the third quarter (pro-tip: the actual balance of payments numbers for q3 won’t be out until December; watch the banking data for higher frequency clues).

Trump’s multi-front trade war has not been limited to China. I don’t see the argument for pulling out of NAFTA even on Trumpian terms; trade within North America is far more balanced than global trade.

More on:

International Economic Policy

Trade

Capital Flows

But, well, there is the inconvenient fact that, thanks to China’s unloved stimulus, the biggest aggregate trade imbalances these days are found in America’s Asian allies and in Europe.

China’s domestic imbalances have, for now, limited its contribution to global payments imbalances. I still think the policies needed to allow China to pull back on its stimulus without returning to a large surplus don’t get enough attention (they sort of got relegated to the back pages in the latest IMF article IV).

And Korea, Taiwan, Sweden, Switzerland, and the Eurozone (both its surplus countries and in aggregate) really could benefit from a somewhat looser fiscal policies.

The gap between the United States’ fiscal stance (too loose) and the fiscal stance of most surplus countries (too tight) is currently the number one underlying cause of currency misalignments and trade imbalances.

I ended up writing more about emerging economies than I expected—the ability of the Turkish banking system to transform dollar funding into lira lending is fascinating, and the persistence of the financing that allows Turkey to sustain ongoing deficits remains a mystery. I should have been paying more attention to Argentina’s current account and external debt dynamics last year—its current account deficit was rising even before this year’s bad harvest, putting its external debt on a potentially explosive path. Its need to turn to the IMF shouldn’t have been a surprise.[1]

The IMF is doing a better job assessing most countries’ balance of payments positions these days—big surpluses are getting a bit more attention alongside big deficits, and I like many of the methodological refinements that have been made to the Fund’s methodology for assessing external balances. But the IMF continues to be let down by its (newish) reserve metric. It missed Argentina’s vulnerability, for example, and overstates Vietnam’s need for reserves. I worry that many analysts are using it uncritically: China in no way needs a buffer of $3 trillion given its limited external debts.[2]

I had fun taking a technique usually applied to emerging economies—charting cumulative flows to estimate stocks—and applying it to capital flows to the United States over the last thirty years. It turns out to provide a useful window into the net international investment position data—net FDI flows into the U.S. have been flat, so it shouldn’t really be a surprise that the U.S. doesn’t have a large positive net FDI position anymore. It will be interesting to see if rising rates start to have a material impact on the size of the United States current account balance; I certainly expect this effect to become more visible soon. I hope to soon start charting cumulative contributions from real net exports too.

Finally, I think there is now growing technical consensus that FDI flows are deeply distorted by tax—most flows globally are to and from a low tax jurisdiction, and even after the tax reform, most of the profits booked by U.S. firms abroad continue to appear in a few low tax jurisdictions, and well, the resulting data distortions are getting pretty big. I am pretty confident the U.S. tax reform didn’t solve the issue of profit-shifting. Now if there were just a consensus on what to do to fix the problem.

I want to do a bit more on the role tax arbitrage plays in the generation of dark matter (to use Hausmann and Sturzenegger’s phrase) going forward—and to get back to writing on the Eurozone a bit more. And I plan to continue delving into the risks hiding on the balance sheets of Asian insurers. Japan is almost as interesting as Taiwan.

But with $200 billion in tariffs on China lined up for early September, I have a feeling that I may not be able to entirely escape trade. Especially as China’s retaliation against the U.S. will really start to bite when the harvest comes in.

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  1. ^ I am impressed that the IMF determined that Argentina was not sustainable with a high probability—and still found enough flexibility inside the latest access decision to provide large scale financing without a bond restructuring (on the sensible grounds that most of Argentina’s bonds were already long-term and thus the bond holders were not a source of short-term balance of payments pressure). I worried that the IMF would be compelled by the new access policy to find most countries sustainable with a high probability.
  2. ^ The reserve metric consistently overstates the reserve needs of Asian surplus economies and consistently understates the reserve need of liability dollarized emerging economies with current account deficits. This is largely because the ratio of m2 to GDP varies enormously across countries. High savings Asian economies tend to have high m2 to GDP ratios and thus current account surpluses, and low saving emerging economies with small domestic banking systems tend to have both external deficits and a high level of liability dollarization. Reserves to short-term external debt, or even a “naïve” variable like reserves to GDP, works better.